Thursday, June 21, 2012

EL DESASTRE DE UNA ESTRATEGIA

Chancellor Angela Merkel has sent word that Germany cannot save the euro. She is right.

From the very start of the Eurozone crisis, it was clear that a domino game was under way and that a highly indebted German government should not be seen as the residual saviour. But keeping the euro will be costly and Germany will have to share the burden.

The solution will have to combine debt structuring and ECB lending in last resort to banks and governments. Angela Merkel needs now to lift the German veto.

All Eurozone leaders, including Mrs Merkel, are to blame for today’s predicament.

The politically expedient decision of May 2010 – to bailout Greece but promise that it would be “unique and exceptional” – was officially sold as necessary to avoid contagion.

Two years later, it is obvious that this has been a historical but predictable policy mistake (Wyplosz 2010).

The crisis has engulfed three small countries – Greece, Ireland and Portugal – and is now on its way towards Spain and Italy. France might well be next. These six countries’ public debts amount to 200% of German GDP. With its own debt of 80% of GDP, Germany cannot indeed stop the rot.

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The May 2010 strategy is a disaster: Admit mistakes and move on

The strategy adopted in May 2010 has not just failed to achieve its aims: restore debt sustainability, avoid contagion and reduce moral hazard. It has not produced a solution that is likely to bring the crisis to its end. A 180-degree turn is still needed.

Unfortunately it will be costly.

A number of countries will never be able to achieve sustainable growth under the weight of their current public debts.

This is the case of Greece, Portugal and Italy,

The list may eventually widen to include Ireland, Spain and France.

Their governments will have to restructure their debts, totally in the case of Greece, partially – if done early enough – in the other cases.

As the banks in these nations fail (because they did not adequately diversify their portfolios), bank bailouts will also have to be financed from outside.

Who will pay?

Foreign banks will, of course, end up writing down the restructured sovereign debt; they, in turn, may have to be bailed out by their own governments.

Official creditors too will suffer losses.

This includes the ECB, to the extent that it imposed insufficient haircuts in its various refinancing programs, and the shareholders of the EFSF and the ESM, which also happen to be the shareholders of the ECB.

Waiting only raises the eventual price

The more we wait, the deeper the economic deterioration – more lending to governments and more non-performing loans in banks – and the bigger the eventual costs.

Importantly, the list of ‘bailer outs’ shrinks as the list of ‘bailed outs’ expands, so the costs of the rescue become concentrated on a decreasing number of healthy countries.

Waiting too long implies that there is no healthy country left or no Eurozone any more, probably both.